Category Archives: Banking

Buried deep in today’s FOMC Minutes was a warning to the equity markets that few noticed…

This overall assessment incorporated the staff’s judgment that, since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets…

According to another view, recent rises in equity prices might be part of a broad-based adjustment of asset prices to changes in longer-term financial conditions, importantly including a lower neutral real interest rate, and, therefore, the recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.

According to one view, the easing of financial conditions meant that the economic effects of the Committee’s actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.

Roughly translated means – higher equity prices are driving financial conditions to extreme ‘easiness’ and The Fed needs to slow stock prices to regain any effective control over monetary conditions.

And with that ‘explicit bubble warning’, it appears the ‘other’ side of the cycle, thatHussman Funds’ John Hussmanhas been so vehemently explaining to investors, is about to begin…

Nothing in history leads me to expect that current extremes will end in something other than profound disappointment for investors. In my view, the S&P 500 will likely complete the current cycle at an index level that has only 3-digits. Indeed, a market decline of -63% would presently be required to take the most historically reliable valuation measures we identify to the same norms that they have revisited or breached during the completion of nearly every market cycle in history.

The notion that elevated valuations are “justified” by low interest rates requires the assumption that future cash flows and growth rates are held constant. But any investor familiar with discounted cash flow valuation should recognize that if interest rates are lower because expected growth is also lower, the prospective return on the investment falls without any need for a valuation premium.

At present, however, we observe not only the most obscene level of valuation in history aside from the single week of the March 24, 2000 market peak; not only the most extreme median valuations across individual S&P 500 component stocks in history; not only the most extreme overvalued, overbought, over bullish syndromes we define; but also interest rates that are off the zero-bound, and a key feature that has historically been the hinge between overvalued markets that continue higher and overvalued markets that collapse: widening divergences in internal market action across a broad range of stocks and security types, signaling growing risk-aversion among investors, at valuation levels that provide no cushion against severe losses.

We extract signals about the preferences of investors toward speculation or risk-aversion based on the joint and sometimes subtle behavior of numerous markets and securities, so our inferences don’t map to any short list of indicators. Still, internal dispersion is becoming apparent in measures that are increasingly obvious. For example, a growing proportion of individual stocks falling below their respective 200-day moving averages; widening divergences in leadership (as measured by the proportion of individual issues setting both new highs and new lows); widening dispersion across industry groups and sectors, for example, transportation versus industrial stocks, small-cap stocks versus large-cap stocks; and fresh divergences in the behavior of credit-sensitive junk debt versus debt securities of higher quality. All of this dispersion suggests that risk-aversion is rising, no longer subtly. Across history, this sort of shift in investor preferences, coupled with extreme overvalued, overbought, over bullish conditions, has been the hallmark of major peaks and subsequent market collapses.

The chart below shows the percentage of U.S. stocks above their respective 200-day moving averages, along with the S&P 500 Index. The deterioration and widening dispersion in market internals is no longer subtle.

Market internals suggest that risk-aversion is now accelerating. The most extreme variants of “overvalued, overbought, over bullish” conditions we identify are already in place.

A market loss of [1/2.70-1 =] -63% over the completion of this cycle would be a rather run-of-the-mill outcome from these valuations. All of our key measures of expected market return/risk prospects are unfavorable here. Market conditions will change, and as they do, the prospective market return/risk profile will change as well. Examine all of your investment exposures, and ensure that they are consistent with your actual investment horizon and tolerance for risk.

The report shows serious credit card delinquencies rose for the third consecutive quarter, a trend not seen since 2009.

Let’s take a look at a sampling of report highlights and charts.

Household Debt and Credit Developments in 2017 Q2

Aggregate household debt balances increased in the second quarter of 2017, for the 12th consecutive quarter, and are now $164 billion higher than the previous (2008 Q3) peak of $12.68 trillion.

As of June 30, 2017, total household indebtedness was $12.84 trillion, a $114 billion (0.9%) increase from the first quarter of 2017. Overall household debt is now 15.1% above the 2013 Q2 trough.

The distribution of the credit scores of newly originating mortgage and auto loan borrowers shifted downward somewhat, as the median score for originating borrowers for auto loans dropped 8 points to 698, and the median origination score for mortgages declined to 754.

Student loans, auto loans, and mortgages all saw modest increases in their early delinquency flows, while delinquency flows on credit card balances ticked up notably in the second quarter.

Outstanding student loan balances were flat, and stood at $1.34 trillion as of June 30, 2017. The second quarter typically witnesses slow or no growth in student loan balances due to the academic cycle.

11.2% of aggregate student loan debt was 90+ days delinquent or in default in 2017 Q2.

Total Debt and Composition:

Mortgage Origination by Credit Score:

Auto Origination by Credit Score:

30-Day Delinquency Transition:

90-Day Delinquency Transition:

Credit card and auto loan delinquencies are trending up. The trend in mortgage delinquencies at the 30-day level has bottomed. A rise in serious delinquencies my follow.

For the first time in four months, BofAML’s Global Financial Market Stress index has turned positive – signalling more market stress than normal.

As the spat between North Korea and the U.S. worsened, a measure of cross-asset risk, hedging demand and investor flows awakened from its torpor (after spending 78 straight days below zero – with stress below normal).

The problem the world faces is… did the world’s central bank money-printing safety net just lose its plunge protection power?

For context, this is the biggest spike in the Global Financial Stress Index since the US ratings downgrade in August 2011 – and a bigger shock than the August 2015 China devaluation…

… Michael Pento sits down with best selling author and National security expert Jim Rickards to talk about North Korea, debt the stock markets and when this all unravels.

Unofficially, Libor died some time in 2012 when what until then was a giant “conspiracy theory” – namely that the world’s most important reference index, setting the price for $350 trillion in loans, credit and derivative securities had been rigged for years – was confirmed.Officially, Libor died earlier today when the top U.K. regulator, the Financial Conduct Authority which regulates Libor, said the scandal-plagued index would be phased out and that work would begin for a transition to alternate, and still undetermined, benchmarks by the end of 2021.

As Andrew Bailey,chief executive of the FCA, explainedthe decision to eliminate Libor was made as the amount of interbank lending has hugely diminished and as a result “we do not think markets can rely on Libor continuing to be available indefinitely.”

He is right: whether as a result of central banks effectively subsuming unsecured funding needs, or simply due to trader fears of being caught “red-handed” for simply trading it, the number of transactions directly involving Libor have virtually ground to a halt.According to the WSJ, “in one case banks setting the Libor rate for one version of the benchmark executed just 15 transactions in that currency and duration for the whole of 2016.”

As the WSJ adds, the U.K. regulator has the power to compel banks to submit data to calculate the benchmark. “But we do not think it right to ask, or to require, that panel banks continue to submit expert judgments indefinitely,” he said, adding that many banks felt “discomfort” at the current set up. The FCA recently launched an exercise to gather data from 49 banks to see which institutions are most active in the interbank lending market.

Commeting on the decision, NatWest Markets’ Blake Gwinn told Bloomberg that the decision was largely inevitable: “There had never been an answer as to how you get market participants to adopt a new benchmark. It was clear at some point authorities were going to force them. The FCA can compel people to participate in Libor. What can ICE do if they’ve lost the ability to get banks to submit Libor rates?”

Gwinn then mused that “in the meantime, what’s today’s trade? The U.K. has Sonia, but the U.S. doesn’t have a market. There’s still so much uncertainty at this point” Yesterday, “a Libor swap meant something. Now you can’t rely on swaps for balance-sheet hedging.”

And so the inevitable decision which many had anticipated, was finally made: after 2021 Libor will be no more.

Below is a brief history of what to many was and still remains the most important rate:

2017: U.K. regulator plans to phase in Libor alternatives over five years.

Yet while anticipated, the surprising announcement of Libor’s upcoming death has taken many traders by surprise, not least because so many egacy trades still exist. As BLoomberg’s Cameron Crise writes, “There is currently an open interest of 170,000 eurodollar futures contracts expiring in 2022 and beyond – contracts that settle into a benchmark that will no longer exist. What are existing contract holders and market makers supposed to do?“

Then there is the question of succession: with over $300 trillion in derivative trades, and countless billion in floating debt contracts, currently referening Libor, the pressing question is what will replace it, and how will the transition be implemented seamlessly?

The FCA’s CEO didn’t set out exactly what a potential replacement for Libor might look like but a group within the Bank of England is already working on potential replacements. “However, any shift will have to be phased in slowly.”

Bailey said it was up to the IBA and banks to decide how to move Libor-based contracts to new benchmarks. After 2021 IBA could choose to keep Libor running, but the U.K. regulator would no longer compel banks to submit data for the benchmark.

The Fed has already been gearing up for the replacement: last month the Alternative Reference Rates Committee, a group made up of the largest US banks, voted to use a benchmark based on short-term loans known as repurchase agreements or “repo” trades, backed by Treasury securities, to replace U.S. dollar Libor. The new rate is expected to be phased in starting next year,and the group will hold its inaugural meeting in just days, on August 1.

The problem with a repo-based replacement, however, is that it will take the placidity of the existing reference rate, and replace it with a far more volatile equivalent. As Crise points, out, “since 2010 the average daily standard deviation of three month dollar Libor is 0.7 basis points. The equivalent measure for GC repo is 4.25 bps. That’s a completely different kettle of fish.”

So as the countdown to 2021 begins, what replaces Libor is not the only question: a bigger problem, and perhaps the reason why Libor was so irrelevant since the financial crisis, is that short-term funding costs since the financial crisis were virtually non-existent due to ZIRP and NIRP. Now that rates are once again rising, the concern will be that not does a replacement index have to be launched that has all the functionality of Libor (ex rigging of course), but that short-term interest rates linked to the Libor replacement will be inevitably rising. And, for all those who follow funding costs and the upcoming reduction in liquidity in a world of hawkish central banks, this means that volatility is guaranteed. In other words, this forced transition is coming in the worst possible time.

Then again, as many have speculated, with the next recession virtually assured to hit well before 2021, it is much more likely that this particular plan, like so many others, will be indefinitely postponed long before the actual deadline.

Like this:

Each new policy destroys another level of prudent fiscal/financial discipline.

The primary driver of our economy–financialization–is in a death spiral. Financialization substitutes expansion of interest, leverage and speculation for real-world expansion of goods, services and wages.

Financial “wealth” created by leveraging more debt on a base of real-world collateral that doesn’t actually produce more goods and services flows to the top of the wealth-power pyramid, driving the soaring wealth-income inequality we see everywhere in the global economy.

As this phantom wealth pours into assets such as stocks, bonds and real estate, it has pushed the value of these assets into the stratosphere, out of reach of the bottom 95% whose incomes have stagnated for the past 16 years.

The core problem with financialization is that it requires ever more extreme policies to keep it going. These policies are mutually reinforcing, meaning that the total impact becomes geometric rather than linear. Put another way, the fragility and instability generated by each new policy extreme reinforces the negative consequences of previous policies.

These extremes don’t just pile up like bricks–they fuel a parabolic rise in systemic leverage, debt, speculation, fragility, distortion and instability.

This accretive, mutually reinforcing, geometric rise in systemic fragility that is the unavoidable output of financialization is poorly understood, not just by laypeople but by the financial punditry and professional economists.

Gordon Long and I cover the policy extremes which have locked our financial system into a death spiral in a new 50-minute presentation, The Road to Financialization. Each “fix” that boosts leverage and debt fuels a speculative boom that then fizzles when the distortions introduced by financialization destabilize the real economy’s credit-business cycle.

Each new policy destroys another level of prudent fiscal/financial discipline.

The discipline of sound money? Gone.

The discipline of limited leverage? Gone.

The discipline of prudent lending? Gone.

The discipline of mark-to-market discovery of the price of collateral? Gone.

The discipline of losses being absorbed by those who generated the loans? Gone.

And so on: every structural source of discipline has been eradicated, weakened or hollowed out. Financialization has consumed the nation’s seed corn, and the harvest of instability is ripening in the fields of finance and the real economy alike.

(ZeroHedge) Sir Richard Branson once said that the quickest way to become a millionaire was to take a billion dollars and buy an airline. But, as EnerVest Ltd, a Houston-based private equity firm that focuses on energy investments, recently found out, there’s more than one way to go broke investing in extremely volatile sectors.

As theWall Street Journalpoints out today, EnerVest is a $2 billion private-equity fund that borrowed heavily at the height of the oil boom to scoop up oil and gas wells. Unfortunately, shortly after those purchases were made, energy prices plunged leaving the fund’s equity, supplied primarily by pensions, endowments and charitable foundations, worth essentially nothing.

The outcome will leave investors in the 2013 fund with, at most, pennies for every dollar they invested, the people said. At least one investor, the Orange County Employees Retirement System, already has marked its investment down to zero, according to a pension document.

Though private-equity investments regularly flop, industry consultants and fund investors say this situation could mark the first time that a fund larger than $1 billion has lost essentially all of its value.

EnerVest’s collapse shows how debt taken on during the drilling boom continues to haunt energy investors three years after a glut of fuel sent prices spiraling down.

But, at least John Walker, EnerVest’s co-founder and chief executive, expressed some remorse for investors by confirming to the WSJ that they “are not proud of the result.”

All of which leaves EnerVest with the rather unflattering honor of being perhaps the only private equity fund in history to ever raise over $1 billion in capital from investors and subsequently lose pretty much 100% of it.

Only seven private-equity funds larger than $1 billion have ever lost money for investors, according to investment firm Cambridge Associates LLC. Among those of any size to end in the red, losses greater than 25% or so are almost unheard of, though there are several energy-focused funds in danger of doing so, according to public pension records.

EnerVest has attempted to restructure the fund, as well as another raised in 2010 that has struggled with losses, to meet repayment demands from lenders who were themselves writing down the value of assets used as collateral, according to public pension documents and people familiar with the efforts.

A number of prominent institutional investors are at risk of having their investments wiped out, including Caisse de dépôt et placement du Québec, Canada’s second-largest pension, which invested more than $100 million. Florida’s largest pension fund manager and the Western Conference of Teamsters Pension Plan, a manager of retirement savings for union members in nearly 30 states, each invested $100 million, according to public records.

The fund was popular among charitable organizations as well. The J. Paul Getty Trust, John D. and Catherine T. MacArthur and Fletcher Jones foundations each invested millions in the fund, according to their tax filings.

Michigan State University and a foundation that supports Arizona State University also have disclosed investments in the fund.

Luckily, we’re somewhat confident that at least the losses accrued by U.S.-based pension funds will be ultimately be backstopped by taxpayers…so no harm no foul.

A Swiss bank is now offering to buy bitcoins for its clients. As of Wednesday, investors can ask their asset manager atFalcon Private Bank, a boutique investment firm headquartered in Zurich, to purchase and storebitcoinon their behalf – a first for conventional banks. Despite the cryptocurrency’s infamous volatility, this is another indication that is here to stay.

“We have various clients that are interested in buying bitcoin for investment purposes, and we’re making it very convenient for them,” says Arthur Vayloyan, the global head of products and services at Falcon. Because Falcon will be doing the buying and storing of the digital coins, its customers won’t require any specialist knowledge to switchtheir cash into bitcoin. The Swiss financial authority, FINMA, granted Falcon regulatory approval on Tuesday.

But some worry that people may be underestimating the importance of decentralisation to thedigital currency. Traditional banks that hold large sums of bitcoin for their customers will be obvious targets for hackers. “It’s a lot easier to steal digital currency than a traditional currency,” sayAndreas Antonopoulos, host of the Let’s Talk Bitcoin podcast.

Spaced out

“This is why decentralisation is so important,” Antonopoulos says. Indeed, Bitcoin is built on decentralization. Instead of central banks and governments, Bitcoin relies on a network of computers that anyone can join to check the legitimacy of transactions. Every Bitcoin is accounted for on a digital ledger called the blockchain that records how many coins each digital wallet holds.

Whenever currency changes hands, everyone on the network updates their copy of the blockchain too. Underpinning the whole system is some complex mathematics that makes it incredibly difficult to deceive or control without infeasible amounts of computing power.

The wallets are decentralized too. Instead of bank accounts, anyone can create and store their own bitcoin wallet. Because there isno centralised collection of wallets, there is no central target for hackers to try to steal large amounts of digital currency. Or atleast that’s the idea (in practice centralised pockets can emerge).

Put lots of wallets in the same place, and the system may no longer hold. If a thousand people each hold a single bitcoin, a certain level of security will be sufficient protection. However, if one place holds a thousand bitcoin, you increase the appeal to hackers a thousand-fold too, which means you have to similarly up the security. “But there is no way to do this. By putting in more eggs you make the basket weaker,” says Antonopoulos.

Hack attack

We have seen this problem before in exchanges, where people trade different digital and traditional currencies. The biggest of these until 2014 was Mount Gox, which at the time was handling more than half of all bitcoin transactions. In February of that year, 850,000 bitcoins corresponding to $450 million at the time went missing, with most thought to have been stolen by hackers.

Only a few years ago, many conventional banks still thought that bitcoin was doomed to fail, but as the price has soared and it has continued to survive, it hasbecome too attractive for investors to resist. In 2012, you could buy a bitcoin for less than $10, last month they were selling for a record high of $3000. Illustrating the currency’s volatility, it’s currently trading at just under $2500, but overall has tripled in value in the last year alone.

Users of Falcon’s bitcoin service will have to sign a waiver to show that they understand the risks, as they would with other high risk investments. In future, the bank plans to expand to other digital currencies.